Latham & Watkins Energy Regulatory & Markets Industry Group
June 2, 2014 | Number 1691
Federal Appeals Court Decision Could Create Risk for
Demand Response Suppliers in Wholesale Markets
D.C. Circuit Court vacates FERC Order No. 745 on demand response compensation,
determining that FERC does not have jurisdiction.
On May 23, 2014, the U.S. Court of Appeals for the D.C. Circuit Court issued a decision in Electric Power
Supply Association v. FERC (EPSA) vacating and remanding the Federal Energy Regulatory
Commission’s (FERC’s or Commission’s) Order No. 745, which provides compensation for demand
response resources that participate in the energy markets administered by Regional Transmission
Organizations (RTOs) and Independent System Operators (ISOs). The decision holds that FERC did not
have jurisdiction under the Federal Power Act (FPA) to issue Order No. 745 because demand response is
part of the retail market, which is exclusively within the states’ jurisdiction to regulate. Furthermore, the
court holds that even if FERC did have jurisdiction under the FPA to issue Order No. 745, the Order
would still fail as arbitrary and capricious because FERC failed to properly consider concerns of the
petitioner and other parties that Order No. 745 would result in unjust and unreasonable rates because it
would overcompensate demand response resources.
Background
As detailed in a prior Clean Energy Law Report post, Order No. 745 requires demand response resources
participating in the organized wholesale energy markets administered by RTOs and ISOs to be paid the
full market clearing locational marginal price of energy (LMP) where (1) the demand response resource is
capable of replacing a generation resource and (2) dispatch of the resource is deemed to be costeffective through the application of a “net benefits test.” The Energy Power Supply Association appealed
Order No. 745 after FERC upheld the Order on rehearing. Both Order No. 745 and FERC’s order on
rehearing, Order No. 745-A, were issued over the dissent of FERC Commissioner Philip D. Moeller, who
argued that paying demand response resources full LMP overcompensates those resources because in
addition to any incentive payments received, those resources also receive the benefit of not paying the
cost of retail energy consumption that they otherwise would have incurred.
In its orders and on brief before the D.C. Circuit, FERC clarified that its jurisdiction under the FPA over
demand response was not direct because FERC does not view demand response as a wholesale sale of
electricity, or even a sale of electricity. Instead, FERC asserted that Sections 205 and 206 of the FPA
granted it jurisdiction because these provisions require FERC to ensure that all rules and regulations
affecting rates in connection with the wholesale sale of electricity are just and reasonable. FERC also
asserted that its exercise of jurisdiction through Order No. 745 was supported by the Congressional policy
statement in § 1292(f) of the Energy Policy Act of 2005 (EPAct of 2005), which encourages the removal
of barriers to demand response participation in organized wholesale energy markets.
Latham & Watkins operates worldwide as a limited liability partnership organized under the laws of the State of Delaware (USA) with affiliated limited liability partnerships conducting the practice in the United
Kingdom, France, Italy and Singapore and as affiliated partnerships conducting the practice in Hong Kong and Japan. The Law Office of Salman M. Al-Sudairi is Latham & Watkins associated office in the
Kingdom of Saudi Arabia. In Qatar, Latham & Watkins LLP is licensed by the Qatar Financial Centre Authority. Under New York’s Code of Professional Responsibility, portions of this communication contain
attorney advertising. Prior results do not guarantee a similar outcome. Results depend upon a variety of factors unique to each representation. Please direct all inquiries regarding our conduct under New York’s
Disciplinary Rules to Latham & Watkins LLP, 885 Third Avenue, New York, NY 10022-4834, Phone: +1.212.906.1200. © Copyright 2014 Latham & Watkins. All Rights Reserved.
EPSA Decision
In EPSA the D.C. Circuit squarely rejects FERC’s reliance on its “affecting” jurisdiction under Sections
205 and 206 of the FPA as unreasonable because it “has no limiting principle” and “could ostensibly
authorize FERC to regulate any number of areas, including the steel, fuel and labor markets.” The court
instead finds that the limits of FERC’s “affecting” jurisdiction are best determined by Section 201 of the
FPA, which states that FERC’s jurisdiction “extend[s] only to those matters which are not subject to
regulation by the States.” The court thus finds that the FPA unambiguously restricts FERC from regulating
the retail market and Order No. 745 results in impermissible regulation under the FPA because demand
response is part of the retail market—“[i]t involves retail customers, their decision whether to purchase at
retail, and the levels of retail electricity consumption.”
The court also rejects FERC’s reliance on EPAct of 2005, finding that FERC cannot rely on a statement of
Congressional policy as an independent source of jurisdictional authority. Moreover, the court finds that in
Order No. 745 FERC “went far beyond removing barriers to demand response resources” and instead
drew these resources into the wholesale market and dictated the compensation they must receive.
As mentioned above, in EPSA the D.C. Circuit did not stop at invalidating Order No. 745 on jurisdictional
grounds. The court also finds that FERC failed to properly consider and engage “reasonable (and
persuasive)” arguments by Commissioner Moeller and various parties that Order No. 745
overcompensates demand response providers. The court finds that FERC did not adequately explain how
Order No. 745 results in just and reasonable compensation and therefore holds that the Order is arbitrary
and capricious.
Dissent
Judge Edwards issued a strong dissent from the majority’s decision in EPSA. Judge Edwards begins his
dissent observing that the D.C. Circuit and the Supreme Court have recognized that the jurisdictional line
between FERC’s wholesale jurisdiction and the states’ retail jurisdiction “is neither neat nor tidy.” He then
asserts that Order No. 745 could be viewed as falling on either side of this jurisdictional line as the FPA
does not unambiguously speak to the issue. Given this asserted ambiguity, he argues that the court
should defer to FERC’s interpretation under the Chevron doctrine. Judge Edwards emphasizes that Order
No. 745 does not intrude on state authority over retail sales or markets because the order only calls for
compensation of demand response resources where such resources are permitted under state law to
participate in organized wholesale energy markets. He asserts that there is a limiting principle to FERC’s
jurisdictional authority under Sections 205 and 206 of the FPA: FERC cannot directly regulate retail sales
and FERC can only issue regulations that either directly affect or are closely related to wholesale rates.
Judge Edwards concludes that Order No. 745 falls comfortably within this limiting principle. Finally, Judge
Edwards asserts that FERC did respond to arguments that Order No. 745 overcompensates demand
response providers. He argues that the court should defer to FERC regarding the proper compensation
scheme because the Commission put forth a reasonable explanation that compensating demand
response resources at full LMP would provide the proper incentive for demand response providers to
overcome market barriers.
Vacatur and Remand
The D.C. Circuit’s decision vacating and remanding Order No. 745 will not go into effect immediately
because the court, on its own motion, is withholding the mandate of its decision until seven days after the
disposition of any timely petition for rehearing. In order to be timely, a rehearing request must be
submitted within 45 days from the court’s decision. Beyond rehearing before the D.C. Circuit any
subsequent appeal in this case that might be heard would be before the US Supreme Court.
Latham & Watkins
June 2, 2014 | Number 1691 | Page 2
Implications
Order No. 745 is limited to the compensation to be provided to demand response resources in organized
wholesale energy markets. However, the scope of the D.C. Circuit’s holding in EPSA that FERC does not
have jurisdiction under the FPA over demand response because demand response is part of the retail
market is potentially much broader and could impact other organized wholesale power markets for which
FERC has required or approved participation of demand response resources. For example, in 2008 and
2009, FERC required RTOs and ISOs to allow for participation of demand response resources in RTO
and ISO ancillary service markets on a comparable basis to other resources in Order Nos. 719 and 719-A
(and in this latter order FERC relied on its “affecting” jurisdiction). In addition, prior to these orders, FERC
had already approved tariffs for RTOs and ISOs that included provisions regarding participation of
demand response resources in their capacity markets (though the jurisdictional issues addressed in those
orders did not relate specially to whether FERC has jurisdiction to approve demand response resources
participation in the capacity markets). And, in some of the earliest orders approving the participation of
demand response resources in organized wholesale markets, such as emergency load response
programs, FERC based its jurisdiction on a finding that such participation was considered to be wholesale
in nature when it involved the sale for resale of energy that would ordinarily have been consumed by a
retail consumer.
The potentially broader impact of the holding in EPSA is not just theoretical. On the same day that the
D.C. Circuit issued its decision in EPSA, a participant in the capacity market administered by PJM
Interconnection LLC (PJM) filed an emergency complaint at FERC requesting that FERC order PJM to
remove all portions of its tariff allowing or requiring PJM to include demand response as suppliers in its
capacity markets, with a refund effective date of May 23, 2014. This complaint further requests that FERC
issue an order requiring PJM to delay the results of its most recent capacity auction (which was
completed on May 23, 2014, and in which a total of more than 10,000 MW of demand response
resources were procured) pending rehearing of EPSA because these auction results must be considered
void and legally invalid because of the inclusion of demand response resources. Application of the court’s
holding in EPSA to prospectively or retroactively disallow demand response resources to participate in
organized wholesale capacity markets could have serious consequences for demand response suppliers
because demand response resources derive significantly more revenue from participation in these
markets than they do from participation in organized wholesale energy markets. For example, the 2013
State of the Market Report for PJM, that PJM’s capacity market was “the primary source of revenue to
participants in PJM demand response programs.”
Conclusion
The D.C. Circuit’s decision in EPSA raises the possibility that if demand response provisions in existing
ISO and RTO tariffs are determined to be void or legally invalid, demand response providers in certain
instances could be forced to issue refunds for the compensation they have received. Market analysts see
the decision as creating risk for demand response suppliers participating in wholesale markets. PJM has
issued a statement that “PJM hereby advises that it will continue to abide by the terms of its Tariff and
Operating Agreement as relates to demand response in its markets.”
Latham & Watkins
June 2, 2014 | Number 1691 | Page 3
If you have questions about this Client Alert, please contact one of the authors listed below or the Latham
lawyer with whom you normally consult:
Michael J. Gergen
[email protected]
+1.202.637.2188
Washington, D.C.
Natasha Gianvecchio
[email protected]
+1.202.637.1079
Washington, D.C.
David L. Schwartz
[email protected]
+1.202.637.2125
Washington, D.C.
Jared W. Johnson
[email protected]
+1.202.637.2362
Washington, D.C.
Michael (Tyler) Brown
[email protected]
+1.202.637.3326
Washington, D.C.
Client Alert is published by Latham & Watkins as a news reporting service to clients and other friends.
The information contained in this publication should not be construed as legal advice. Should further
analysis or explanation of the subject matter be required, please contact the lawyer with whom you
normally consult. A complete list of Latham’s Client Alerts can be found at www.lw.com. If you wish to
update your contact details or customize the information you receive from Latham & Watkins, visit
http://events.lw.com/reaction/subscriptionpage.html to subscribe to the firm’s global client mailings
program.
Latham & Watkins
June 2, 2014 | Number 1691 | Page 4